Transfer pricing in SMEs critical analysis and practical solutions (contributions to management science)

In the EU, transfer pricing compliance means adherence to the arm’s lengthprinciple stipulated in Art 9 of the OECD Model Convention,6 Furthermore, toapply the arm’s length principle in

Contributions to Management Science

Transfer Pricing in SMEs Critical Analysis and Practical Solutions

Mendel University

Brno, Czech Republic

Mendel UniversityBrno, Czech Republic

ISSN 1431-1941 ISSN 2197-716X (electronic)

Contributions to Management Science

ISBN 978-3-319-69064-3 ISBN 978-3-319-69065-0 (eBook)

https://doi.org/10.1007/978-3-319-69065-0

Library of Congress Control Number: 2017955953

© Springer International Publishing AG 2018

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1 Introduction 1

References 7

2 Transfer Pricing Rules for SMEs in the EU 9

2.1 The Arm’s Length Principle: Its History, Purpose and Role in the Twenty-First Century 9

2.2 Comparability Analysis: Key Part of the Application of Arm’s Length Standard 16

2.3 Transfer Pricing Methods and Their Practical Application in the Twenty-First Century 23

2.3.1 Strengths and Weaknesses of Transfer Pricing Methods 25

2.3.2 Practical Application of Transfer Pricing Methods: Critique Aspects 25

2.4 Transfer Pricing Documentation: Proof of the Arm’s Length Standard 36

2.5 Simplified Transfer Pricing Rules for SMEs 44

2.5.1 Simplified Transfer Pricing Measurements: Documentation 48

2.5.2 Other Simplified Transfer Pricing Measurements 53

2.6 Conclusion and Recommendations 54

References 55

3 Evaluating a Questionnaire on Transfer Pricing Issues of SMEs That Operate in the EU 59

3.1 General Evidence from EU Member States 63

3.2 Compliance Costs and Duration 64

3.3 Suggestions 68

3.4 Conclusion 71

Annex 76

References 81

v

4 Compliance Costs of Transfer Pricing for SMEs 83

4.1 Introduction 83

4.2 Theoretical Background 85

4.2.1 Transfer Pricing Issue 85

4.2.2 Compliance Costs of Taxation 87

4.3 Determination of Compliance Costs of Transfer Pricing: The Czech, Polish and Slovak Cases 88

4.3.1 Data Description and Processing 88

4.3.2 Determination of Compliance Costs 90

4.4 Determination of Compliance Costs of Transfer Pricing for EU Member States 97

4.4.1 Data Description and Processing 97

4.4.2 Determination of Compliance Costs 98

4.5 Conclusions 101

References 103

5 Safe Harbour as an Alternative Approach to Transfer Pricing of SMEs 105

5.1 Relaunching of Safe Harbours 105

5.2 Advantages and Disadvantages of Safe Harbours 108

5.3 Recommendations of the Form and Scope of Safe Harbours 111

5.4 Current Situation of Safe Harbours as Simplified Measurements in European Union 112

5.5 Proposal for Safe Harbours for SMEs 116

5.6 Conclusion 126

References 127

6 CCCTB as a Suitable Solution? 129

6.1 History of the Efforts to Harmonize Corporate Taxation in the EU 129

6.2 Current Situation of Corporate Taxation in the EU 138

6.2.1 Separate Entity Approach Versus Single Entity Approach 138

6.2.2 Corporate Taxation Systems Within the EU 142

6.2.3 Cross-Border Loss Offsetting 143

6.3 Proposal of the CCTB Directive 146

6.4 Proposal of the CCCTB Directive 152

6.5 Is the C(C)CTB Suitable? 155

6.5.1 Methodology 155

6.5.2 Results of the CCTB in the Context of SMEs 160

6.5.3 Results of the CCCTB in the Context of SMEs 167

6.6 Conclusion 180

References 182

7 Conclusion 187

References 192

Fig 2.1 Selecting of external comparables—current practice (EU JTPF

2016, adjusted) 21Fig 2.2 Current application of size indicators in the EU for transfer

pricing purposes (own compilation through Google Charts) 46Fig 2.3 Documentation requirements in relation to size in the EU (own

compilation through Google Charts) 48Fig 3.1 Number and proportion of SMEs (respondents) across NACE

sectors (A Agriculture, forestry and fishing, B Mining and

quarrying,C Manufacturing, D Electricity, gas, steam and air

conditioning supply,E Water supply; sewerage; waste

management and remediation activities,F Construction,

G Wholesale and retail trade; repair of motor vehicles and

motorcycles,H Transporting and storage, I Accommodation andfood service activities,J Information and communication,

K Financial and insurance activities, L Real estate activities,

M Professional, scientific and technical activities,

N Administrative and support service activities, O Public

administration and defence; compulsory social security,

P Education, Q Human health and social work activities, R Arts,entertainment and recreation,S Other services activities)

(compiled by author) 62Fig 3.2 Tax consultant services used by SMEs for transfer pricing issues

(%) (compiled by author) 63Fig 3.3 Simplified measurements used by SMEs (compiled by author) 64Fig 3.4 Average costs and time per year spent managing the transfer

pricing issue (%) (compiled by author) 65Fig 3.5 Average time and costs per year necessary for the selection

of the most suitable transfer pricing method (%) (compiled

by author) 66

vii

Fig 3.6 Average time and costs per year necessary for preparation

of transfer pricing documentation (%) (compiled by author) 67Fig 3.7 Average time and costs per year necessary for preparation

of country-by-country report (%) (compiled by author) 68Fig 3.8 Average time and costs per year necessary for preparation

of APA (%) (compiled by author) 69Fig 3.9 Suggestions related to safe harbours (%) (compiled by author) 71Fig 3.10 The introduction of simplified transfer pricing documentation

for SMEs (%) (compiled by author) 72Fig 3.11 The introduction of lower penalties for SMEs (%) (compiled

by author) 72Fig 3.12 The exclusion of micro and small enterprises from the obligation

to prepare transfer pricing documentation (%) (compiled

by author) 72Fig 3.13 The exclusion of micro and small enterprises from the obligation

of transfer pricing issue (%) (compiled by author) 73Fig 3.14 Availability of complex information for SMEs (%) (compiled

by author) 73Fig 3.15 The implementation of the C(C)CTB system in EU (%)

(compiled by author) 74Fig 3.16 The introduction of EU comparables (benchmarks) for selected

industries (%) (compiled by author) 74Fig 3.17 The introduction of the transfer pricing guidelines for SMEs like

as OECD TP Guidelines (%) (compiled by author) 75Fig 3.18 The possibility of communication with tax authorities in other

language (%) (compiled by author) 75Fig 3.19 The possibility of submitting a tax return in other language (%)

(compiled by author) 75Fig 4.1 Use of tax consultant services for transfer pricing issues (own

processing, questionnaire) 91Fig 4.2 SMEs based on residency (own processing, questionnaire) 97Fig 4.3 Using of tax consultancy in the respect of transfer pricing issues

(own processing, questionnaire) 99Fig 6.1 Re-allocation of cross-border losses of SMEs across the EU

based on the CCTB proposal (own processing, Amadeus

database) 165Fig 6.2 Re-allocation of cross-border losses of SMEs across the

EU—current situation (Fig 6.2 represents the assignment of

cross-border losses based on the tax residency of the subsidiary.)(in EUR) (own compilation through Google Charts, Amadeus

database) 166

Fig 6.3 Re-allocation of cross-border losses of SMEs across the

EU—based on the CCTB (Fig 6.3 represents the assignment

of cross-border losses based on the tax residency of the parentcompany, where loss relief will be applied in accordance withthe CCTB proposal.) (in EUR) (own compilation through GoogleCharts, Amadeus database) 167Fig 6.4 Change in corporate tax liability after the adoption of the

CCCTB system across the EU (in %) (own processing) 176Fig 6.5 Re-allocation of corporate tax liability of SMEs across the

EU—current situation (This figure represents the assignment ofcorporate tax liability based on the tax residency of the

subsidiary.) (in million EUR) (own compilation through GoogleCharts, Amadeus database) 180Fig 6.6 Re-allocation of corporate tax liability of SMEs across

the EU—based on the CCCTB proposal (This figure representsthe assignment of corporate tax liability based on the tax residency

of the subsidiary The limitations of the study—the same tax baseand the same nominal tax rate with the application of an

apportionment formula—are considered.) (in million EUR) (owncompilation through Google Charts, Amadeus database) 181

Table 1.1 Enterprises, employment and gross value added of SMEs in the

EU28, 2015 (Eurostat, National Statistical Offices and DIW

Econ; mentioned in the European Commission 2016) 2Table 2.1 Strengths and weaknesses of traditional transaction methods

(own compilation, TP Guidelines, OECD 2017) 26Table 2.2 Strengths and weaknesses of transactional profit methods—Profit

Split (own compilations, TP Guidelines, OECD 2017) 29Table 2.3 Strengths and weaknesses of transactional profit methods—

TNMM (own compilations, TP Guidelines, OECD 2017) 30Table 2.4 Denominators of net profit level indicators (OECD TP

Guidelines 2017, own processing) 32Table 2.5 Selection of the most appropriate method according to the

circumstances of the case (Cottani 2016) 36Table 2.6 Transfer pricing documentation requirements—OECD and EU

perspective—Master file (TP Guidelines, OECD 2017; EU

Council 2006/C176/01—EU TPD) 38Table 2.7 Transfer pricing documentation requirements—OECD and EU

perspective—Local file (TP Guidelines, OECD 2017, EU

Council, 2006/C176/01—EU TPD) 40Table 2.8 CbCR—OECD and EU perspective (TP Guidelines, OECD

2017; EU Council 2006/C176/01—EU TPD, Directive 2016/

881 and Proposal Directive COM(2016)198) 43Table 2.9 Transfer pricing documentation requirements and exemption

from the transfer pricing rules—SMEs and small transactionperspective (Deloitte 2016; PwC 2015; IBFD 2017) 47Table 2.10 Other transfer pricing simplified measurements—SMEs and

small transaction perspective (Deloitte 2016; PwC 2015; IBFD2017) 53Table 3.1 Classification of respondents across the EU (compiled

by author) 61

xi

Table 3.2 Simplified measurements used by SMEs (For more details

regarding transfer pricing rules and the simplified

measurements that SMEs use, see Chaps 2 and 5) (compiled

by author) 64Table 3.3 Suggested simplified measurements for SMEs (compiled

by author) 70Table 4.1 Data for calculating compliance costs (own processing,

Amadeus, Hays Salary Guide) 90Table 4.2 Transfer pricing documentation—costs and time (own

calculation, questionnaire) 92Table 4.3 Country-by-country report—costs and time (own calculation,

questionnaire) 93Table 4.4 Determination of compliance costs of transfer pricing for

Medium-sized—based on the costs indicator (own calculation,questionnaire, MF Czech Republic, MF Slovak Republic, MF

of Poland) 94Table 4.5 Determination of compliance costs of transfer pricing for

medium-sized—based on the time indicator (own calculation,questionnaire, MF Czech Republic, MF Slovak Republic, MF

of Poland) 95Table 4.6 Determination of compliance costs of transfer pricing for

SMEs (own calculation) 96Table 4.7 Transfer pricing documentation—costs and time—European

Union (own calculation, questionnaire) 100Table 4.8 Determination of compliance costs of transfer pricing for

SMEs—European Union—cost indicator (own calculation) 100Table 4.9 Comparison of compliance costs (own processing, World Bank

Paying Taxes 2017) 102Table 5.1 Advantages and disadvantages of safe harbours (OECD, Multi-

country analysis of existing transfer pricing simplification

measures, 2012 OECD, The comments received with respect

to the discussion draft on the revision of the safe harbours

section of the transfer pricing guidelines, 2012 OECD, TP

Guidelines, 2013 and 2017 Own analysis and processing) 110Table 5.2 Transfer pricing rules in EU Member States (Deloitte (2016),

PwC (2015), IBFD (2017)) 113Table 5.3 Profitability of independent SMEs between 2005 and 2014

for all industry sectors (Amadeus (2015), own processing) 117Table 5.4 Profitability of independent SMEs across industry and

time—median values (Amadeus (2015), own processing) 120Table 5.5 Profitability of independent SMEs across industry sectors

between 2005 and 2014 (Amadeus (2015), own processing) 123Table 5.6 Proposal of safe harbours for selected sectors—small entities

(Amadeus (2015), own processing) 125

Table 5.7 Proposal of safe harbours for selected sectors—medium sized

entities (Amadeus (2015), own processing) 126Table 6.1 Consolidation regimes in the European Union (IBFD research

platform 2016) 142Table 6.2 The application of domestic and cross-border loss relief (IBFD

tax research platform 2016) 144Table 6.3 Methods of cross-border loss relief used by member states that

allow cross-border loss relief (IBFD tax research platform

2016) 145Table 6.4 Nominal corporate tax rate and effective average tax rate in EU

Member States, 2014 (Spengel et al 2014) 158Table 6.5 Distribution of SMEs qualified for the CCTB system across the

EU (own processing, Amadeus database) 161Table 6.6 Classification of losses and profits based on the type of parent

company—assignment to the state of the tax residency of

subsidiary (own processing, Amadeus database) 163Table 6.7 Loss relief and its impact on corporate tax revenue (own

processing, Amadeus database) 168Table 6.8 Employees and expenditures in R&D in business sector in the

EU by size class in 2013 (own processing, Eurostat 2017) 170Table 6.9 Division of SMEs according to their motivation to opt for the

CCCTB or not (own processing, Amadeus database) 172Table 6.10 CCCTB and its impact on corporate tax revenue (Corporate tax

revenue based on the CCCTB system allocated at the level ofthe subsidiary based on its tax residency.)—part A (own

processing, Amadeus database) 174Table 6.11 CCCTB and its impact on corporate tax revenues (The

corporate tax revenues based on the CCCTB system allocated

at the level of subsidiary based on its tax residency.)—part B(own processing, Amadeus database) 175Table 6.12 CCCTB and its impact on corporate tax revenue (The corporate

tax revenue based on the CCCTB system allocated at the level

of subsidiary based on its tax residency.)—part C (own

processing, Amadeus database) 177

APA Advance Pricing Agreements

EBITDA Earnings Before Interest, Tax, Depreciation and Amortization

EU JTPF EU Joint Transfer Pricing Forum

EU TPD Transfer Pricing Documentation for Associated Enterprises

TP Guidelines Transfer Pricing Guidelines for Multinational Enterprises

and Tax Administrations

UN TP Manual Manual on Transfer Pricing for Developing Countries

This chapter presents a brief overview of the importance of small and medium-sizedenterprises (SMEs) and highlights their key role for the EU economy and the majoreconomic issues and obstacles they are facing SMEs occupy a very importantposition in the EU economy, mainly in the area of growth and employment.However, the group of SMEs in the EU is very heterogeneous and differs signif-icantly from large enterprises (LEs) Not only do they differ in size, but they alsoperform different activities, have different needs and require different resources.Currently, SMEs already face special rules in the area of accounting and financialreporting in comparison with LEs; however, SMEs also face specific problems andhave specific needs in the area of practical international taxation issues As studiesshow, SMEs face higher compliance costs of taxation in the internal market,compliance costs connected with transfer pricing and the problem of accessibility

of cross-border loss compensation Taking into account the existing environment inwhich SMEs are operating, this book provides a deep analysis of SMEs’ compli-ance costs with respect to transfer pricing Based on the results of empiricalresearch, this work presents the critical concerns; however, the book also presentssuggestions on simplifying transfer pricing rules for SMEs This book is the result

of a 3-year project (No 15-24867S “Small and medium-sized enterprises in globalcompetition: Development of specific transfer pricing methodology reflecting theirspecificities” granted by the Czech Grant Agency

The European Commission (2003) defines small and medium-sized enterprises(hereinafter, SMEs) based on the number of employees, the volume of turnover, orbalance sheet total Accordingly, SMEs are categorized as micro, small andmedium-sized enterprises Medium-sized enterprises are defined as those “enter-prises employing fewer than 250 persons and having an annual turnover notexceeding EUR 50 million, and/or an annual balance sheet total not exceedingEUR 43 million” Small enterprises are defined as “enterprises having fewer than

50 employees and turnover or balance sheet total less than EUR 10 million.Microenterprises are defined as entities with fewer than 10 employees and a balancesheet total or turnover below EUR 2 million

© Springer International Publishing AG 2018

V Solilova, D Nerudova, Transfer Pricing in SMEs, Contributions to Management

Science, https://doi.org/10.1007/978-3-319-69065-0_1

1

Based on the definition of SMEs used by the European Commission, SMEsaccount for over 99% of all companies in each European country and operate in awide range of sectors In the non-financial sector, they operate mainly in NACEsector I “accommodation and food”, NACE sector M “business services”, NACEsector F “construction”, NACE sector C “manufacturing” and NACE sector G

“wholesale/retail trade” According to the European Commission (2016), thosesectors accounted for 78% of SME employment and 71% of SME value added in

2015 Moreover, with respect to the density of SMEs, the number of SMEs per

100 inhabitants ranged from 2.2 in Romania to 9.4 in the Czech Republic, with 4.5for EU28 (as a whole) as states the European Commission (2016) Furthermore,with respect to SME performance and business environment, SMEs contributesignificantly to total employment According to the European Commission(2016), they provide more than 90 million jobs, mainly in the service sector.Moreover, almost 30% of people employed contribute to micro enterprises, whichaccounted for 37% of the growth in the total employment in 2015 In addition,SMEs contribute to a considerable proportion of value-added (57%), postinggrowth of 5.7% in 2015 (for more details see Table1.1)

According to the surveys conducted,1there is no doubt that the SMEs play a keyrole in the EU economy However, the economic performance of SMEs is stronglyrelated to the EU economy The European Commission (2016) states that the SMEsector is affected by the macroeconomic environment of the EU, i.e., by overalleconomic activity, household consumption, investment expenditures and export of

1 European Commission, Company Taxation in the Internal Market (COM(2001)582 final), and also in Internationalisation of European SMEs (2010) or Modern SME policy for growth and employment (COM(2005)551 final), European Commission Furthermore, in Report on Small and Medium Enterprises and Transfer Pricing, EU Joint transfer pricing forum, European Commission ( 2011 ), and in Annual reports on European SMEs 2013, 2014, 2015 and 2016.

Table 1.1 Enterprises, employment and gross value added of SMEs in the EU28, 2015 (Eurostat, National Statistical Offices and DIW Econ; mentioned in the European Commission 2016 )

goods and services More precisely, the overall economic activity has an impact onthe level of SME activity and employment Household demand has an impact onNACE sector I “accommodation/food”, NACE sector G “retail and wholesaletrade” and “other sectors” Investment expenditures and gross fixed capital forma-tion have an impact on NACE sector F “construction” and NACE sector M

“business services” Exports of goods and services stimulate SME value added inNACE sector C “manufacturing”

With respect to profitability, the European Commission (2016) states that LEsare generally more profitable than SMEs This can be caused by the fact that themost pressing problem faced by SMEs is the lack of market demand and conse-quently finding customers (25%), as well as the availability of skilled staff orexperienced managers (18%), competition (14%), costs of production or labour(13%) and regulation (13%), according to the SAFE report (European Commission

2015b) Moreover, it is important to note that most SMEs focus on their domesticmarket When domestic demand for goods and services showed no growth from

2009 to 2013 and only moderate growth in 2014 and 2015 (between 1.5% and 2%),contrary to the growth of external demand for goods and services, SMEs alsoshowed no growth Furthermore, SMEs usually operate in economic sectors havinglow export intensity However, when they are involved in cross-border activities, it

is mostly on the internal market within EU28 member states The EuropeanCommission (2016) adds that only 1.2 million SMEs are exporting, while 1 million

of them export within the EU

The lower degree of internationalization of SMEs in comparison with LEs can

be considered another aspect causing lower profitability of SMEs Based on thesurvey done by Directorate General of Enterprise and Industry,2only 44% of SMEs(in EU average) are active in any form of international activities (exporting,importing, investing abroad, cooperating internationally, or having internationalsubcontractor relationships) within the EU The most internationalized economicsectors are considered NACE sector G “retail and wholesale trade”, NACE sector B

“mining”, NACE sector C “manufacturing” and NACE sector G “sale of motorvehicles” However, only 2% (for micro), 6% (for small) and 16% (for medium) ofSMEs invest abroad This is connected mainly with the fact that only 5%3of SMEsare associated (having subsidiaries abroad) and that SMEs are less involved incross-border activities The survey further highlights that the lack of capital, lack ofinformation, lack of public support, as well as law and regulations are crucialbarriers for doing international business from the perspective of SMEs

Regarding law and regulations, there are 28 different tax systems in theEuropean Union which may inherently disadvantage SMEs and may have distortiveimpacts on commercial decisions concerning the different business forms and

2 European Commission, Internationalization of European SMEs, 2010 Directorate-General for Enterprise and Industry.

3 European Commission, Observatory of European SMEs, analytical report, 2007 General for Enterprise and Industry.

Directorate-different business activities Already in 2007,4 the European Commissionhighlighted the need for a regulatory environment that would be simple andtransparent with respect to SME issues Its statement is mainly supported by thefact that on average, where a big company spends one euro per employee to complywith a regulatory duty a medium-sized enterprise might have to spend around foureuros and a small business up to 10 euros (European Commission 2007a, b).Moreover, there are different SME definitions for various purposes in the EU,which create the distortions itself within the EU internal market The dispropor-tionately high impact of regulatory requirements also creates disproportionally highcompliance costs in comparison with LEs Understanding the tax system andproposal of an SME-specific tax are therefore critical in the growth of SMEs Inthis context, OECD (2015) states that the provision of SME-specific tax rules can, ifcarefully designed, play a useful role in addressing the challenges and thedisproportionally high tax compliance burdens faced by SMEs.

Considering all of the abovementioned aspects, we assume that the very smallpercentage of SMEs involved in international business activities can also be caused

by the complexity and specialized knowledge required to address internationaltaxation and transfer pricing issues The European Commission (2013a) provedthat the Value Added Tax and corporate taxation are the most burdensome legisla-tive acts for SMEs in the European Union.5In those aspects, SMEs face difficultiesmainly due to the lack of human and financial capital, and due to the lack ofknowledge, experience and resource availability in comparison with LEs Generally,SMEs differ in size, activities, needs and resources in comparison with LEs Itresulted in lower labour productivity, lower profitability, differences in the qualifi-cation and skill levels of the employees and capital intensity Therefore, it is obviousthat SMEs cannot reach the same scale of economy as LEs Moreover, they do nothave the same resources available to bear the high administrative burden to complywith the taxation rules, particularly with transfer pricing rules

In the EU, transfer pricing compliance means adherence to the arm’s lengthprinciple stipulated in Art 9 of the OECD Model Convention,6 Furthermore, toapply the arm’s length principle in practice, the OECD has issued the TransferPricing Guidelines for Multinational Enterprises and Tax Administrations (herein-after, TP Guidelines)7that provide guidance for the application of the arm’s length

4 European Commission, Models to reduce the disproportionate regulatory burden on SMEs Report of the Expert Group Further, European Commission, 2007: Simplified tax compliance procedures for SMEs DG Enterprise Publications.

5 European Commission, Results of the public consultation on the TOP10 most burdensome legislative acts for SMEs http://ec.europa.eu/DocsRoom/documents/10036/attachments/1/ translations

6 OECD ( 2014 ) Model Tax Convention on-income-and-on-capital-2015-full-version-9789264239081-en.htm

http://www.oecd.org/ctp/treaties/model-tax-convention-7 OECD ( 2017 ) Transfer Pricing Guidelines for Multinational Enterprises and Tax tions http://www.oecd.org/tax/transfer-pricing/oecd-transfer-pricing-guidelines-for-multina tional-enterprises-and-tax-administrations-20769717.htm

Administra-principle to pricing for tax purposes and to the cross-border transactions betweenassociated enterprises However, it is clear from the name itself that these TPGuidelines set treatments of transfer pricing issues with respect to multinationalenterprises (hereinafter, MNEs), which are generally LEs In addition, the TPGuidelines make no direct distinction between the types or sizes of MNEs Intheory, all enterprises, regardless of their size, are subject to the same principlesand recommendations We consider that the application of transfer pricing rules inaccordance with Art 9 of the OECD Model Convention and with recommendationsincluded in the TP Guidelines to be very complex and its application for SMEs isconnected with certain difficulties They are compounded by the fact there is neither

a common definition of SMEs for tax purpose in the EU nor symmetry of treatment

of this issue Furthermore, the costs associated with transfer pricing matters can bedisproportionally large for SMEs in comparison to LEs for both the taxpayer andthe tax administration Therefore, we believe that a “one-size fits all” approach isnot possible in the case of SMEs facing transfer pricing issues

Furthermore, there are several studies8 by the European Commissionaddressing the position of SMEs on the internal market and highlighting theimportance of SMEs for the economy Therefore, the European Commissioninitiated several activities to help SMEs The first was in the form of the SmallBusiness Act9 (2008), which aimed to promote competitiveness of SMEs,improve the approach to entrepreneurship in Europe, simplify the regulatoryand policy environment for SMEs, and remove the remaining barriers to theirdevelopment The aims of the Small Business Act are being integrated with theEurope 2020 strategy through the Small Business Act Review,10 where SMEsrepresent the heart of the strategy and its key position is again highlighted Itmust be emphasized that six of the seven Europe 2020 Flagship Initiatives11should help SMEs achieve sustainable growth

The second was when the European Commission established the EU JointTransfer Pricing Forum (hereinafter, JTPF) as an expert group on transfer pricing

8 Examples are European Commission, Modern SME Policy for Growth and Employment COM (2005)551 final European Commission, Company Taxation in the Internal Market COM(2001)

582 final European Commission, Implementation of the community Lisbon programme – munication from the Commission to the Council and the European Parliament – The Contribution

of Taxation and Customs Policies to the Lisbon Strategy COM(2005)532 final European mission, Tackling the corporation tax obstacles of small and medium-sized enterprises in the Internal Market – outline of a possible Home State Taxation pilot scheme COM(2005)702, and also in Internationalisation of European SMEs or Modern SME policy for growth and employment (COM(2005)551 final), European Commission.

Com-9 European Commission, A “Small Business Act” for Europe COM(2008) 394 final http://eur-lex europa.eu/legal-content/EN/TXT/PDF/?uri ¼CELEX:52008DC0394&from¼EN

10 A major landmark in tracking the implementation of the Small Business Act.

11 Smart growth (Digital agenda for Europe, Innovation Union, Youth on the move), Sustainable growth (Resource efficient Europe, An industrial policy for the globalisation era) and Inclusive growth (An agenda for new skills and jobs, European platform against poverty) For more details see: http://ec.europa.eu/europe2020/europe-2020-in-a-nutshell/flagship-initiatives/index_en.htm

on December 2006.12 In 2010, the EU JTPF included the SME transfer pricingissues into the work programme of JTPF and 1 year later issued a report13 withseveral recommendations primarily in the area of compliance costs, definition ofSMEs across EU Member States, dispute resolution and other areas.

With respect to SMEs, the task of the European Commission is to increase theircross-border activities, preserve their competitiveness within the internal marketand to increase their performance, which would remarkably influence the EUeconomy and ensure smart, sustainable and inclusive growth Therefore, we believe

it is necessary to analyse transfer pricing issues in relation to SMEs across the EUMember States and to suggest alternative approaches as a suitable solution fortransfer pricing issues of SMEs This necessary step will contribute to furtherinternationalization of SMEs, which the European Commission considers crucialfor EU economy based on the EU2020 strategy

This book is organized into seven chapters that provide a solid critique of thecurrent approaches in the area of transfer pricing in the context of SMEs based onthe research results of a 3-year project The book focuses on the presentation ofthree specific topics that have not previously been presented in the literature:

• The first topic aims to analyse and document specific transfer pricing rules forSMEs across the EU Chapter2contains an overview of transfer pricing rulesapplied for SMEs across the EU, focusing on simplified measurements, methods,transfer pricing documentation, penalties and tools for ensuring higher certainty,such as advance pricing agreements (APA) Based on the results of the research,

it was possible to determine and categorize the main approaches in transferpricing rules in the context of SMEs and to define the current trend in the rules.Moreover, mapping the transfer pricing rules for SMEs helped to develop aquestionnaire targeting both aims—current approaches in transfer pricing rulesfor SMEs and suggestions for new rules that could be used as a tool fordecreasing compliance costs of transfer pricing Moreover, the questionnairealso served as the main methodological tool for the determination of compliancecosts of transfer pricing, which enabled the research of the second headline topic

of the book In addition, the questionnaire enabled detection of whether SMEswould like to introduce simplified measurements in the area of transfer pricingrules and in which form The evaluation of the questionnaire is presented inChap.3, which focuses on general transfer pricing issues (first aim of the book),compliance costs of transfer pricing (second aim of the book) and tools fordecreasing those compliance costs (third aim of the book)

12 European Commission Commission Decision of 22 December 2006 setting up an expert group

on transfer pricing (2007/75/EC) http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri ¼OJ: L:2007:032:0189:0191:EN:PDF

13 EU JTPF, European Commission, Report on Small and Medium Enterprises and Transfer Pricing http://ec.europa.eu/taxation_customs/sites/taxation/files/resources/documents/taxation/ company_tax/transfer_pricing/forum/jtpf/2011/jtpf_001_final_2011_en.pdf

• The second topic aims to determine the compliance costs of transfer pricingaccording to the results of the questionnaire collected for European SMEs acrossthe EU Member States The results can be found in Chap 4 It should bementioned that the current literature completely lacks the topic of the determi-nation of compliance costs of transfer pricing Studies determining compliancecosts of taxation in relation to Value Added Tax, Corporate Income Tax or othertypes of taxes can be found Based on the results of the research, Chaps.5and6

suggest tools for possible reduction of compliance costs of transfer pricing forSMEs since they can significantly affect the economic performance and interna-tionalization of SMEs in the EU and therefore ensure smart and inclusive growth

• The third topic aims to suggest alternative approaches to the transfer pricingrules in relation to SMEs as a suitable solution for transfer pricing issues ofSMEs, namely, the introduction of safe harbours and a common consolidatedcorporate tax base (CCCTB) Chapter5presents the suggested simplified mea-surement in the form of a safe harbour arm’s length range that can eliminate theconsiderable burden of compliance costs of taxation and make transfer pricingissues easier As a result, SMEs would not be required to perform comparableand functional analysis needed to determine the arm’s length prices or margins.The second alternative approach, CCCTB, can offer different solutions oftransfer pricing issues, as upon entering the CCCTB system, all inter-transactions between associated enterprises would be eliminated and the taxbase of the entire group would be determined based on the new set rules Thissystem not only focuses on transfer pricing issues, but on the taxation ofcorporate enterprises as a whole Moreover, the new proposal of the CCCTBDirective includes some advantages and motivational incentives for SMEs toenter into the systems Therefore, Chap.6includes analysis of this new system ofcorporate taxation and its benefits for SMEs

Finally, Chap.7offers conclusions covering general transfer pricing issues, pliance costs of transfer pricing and suggestion of tools to decrease those compliancecosts in the context of SMEs These results highlight the fact that reducing compliancecosts and simplifying measurement in transfer pricing rules, or a different approachsuch as CCCTB, can significantly affect the economic performance of SMEs and theirinternationalization and can help to achieve the long-term goals of the EU2020agenda, such as smart and inclusive growth in the EU The chapter also presentspolicy recommendations with respect to the EU2020 strategy

com-References

European Commission (2001) Company taxation in the internal market (COM(2001)582 final) https://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/company_tax_study_en.pdf Accessed 10 Nov 2016

European Commission (2003) Recommendation 2003/361/EC of 6 May 2003 http://eur-lex.europa eu/LexUriServ/LexUriServ.do?uri ¼OJ:L:2003:124:0036:0041:en:PDF Accessed 10 Feb 2017

European Commission (2005a) Modern SME policy for growth and employment (COM(2005)551 final) http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri ¼CELEX:52005DC0551& from ¼EN Accessed 10 Feb 2016

European Commission (2005b) Implementation of the community Lisbon nication from the commission to the council and the European parliament—The contribution

programme—Commu-of taxation and customs policies to the Lisbon strategy COM(2005)532 final http://eur-lex europa.eu/procedure/EN/193472 Accessed 20 Feb 2017

European Commission (2005c) Tackling the corporation tax obstacles of small and medium-sized enterprises in the internal market—outline of a possible Home State Taxation pilot scheme, COM(2005)702 http://ec.europa.eu/transparency/regdoc/rep/1/2005/EN/1-2005-702-EN-F1- 1.Pdf Accessed 20 Mar 2017

European Commission (2006) Commission decision of 22 December 2006 setting up an expert group on transfer pricing (2007/75/EC) http://eurlex.europa.eu/LexUriServ/LexUriServ.do? uri ¼OJ:L:2007:032:0189:0191:EN:PDF Accessed 10 Feb 2017

European Commission (2007a) Models to reduce the disproportionate regulatory burden on SMEs Report of the Expert Group http://ec.europa.eu/DocsRoom/documents/10037/attachments/1/ translations Accessed 20 Mar 2017

European Commission (2007b) Simplified tax compliance procedures for SMEs DG Enterprise Publications http://ec.europa.eu/growth/tools-databases/newsroom/cf/itemdetail.cfm?item_

id ¼8379 Accessed 10 Feb 2017

European Commission (2008) A small business act for Europe, COM(2008)394 final lex.europa.eu/legal-content/EN/TXT/?uri ¼CELEX:52008DC0394 Accessed 10 Feb 2017 European Commission (2013a) Results of the public consultation on the TOP 10 most burdensome legislative acts for SMEs http://ec.europa.eu/DocsRoom/documents/10036/attachments/1/ translations Accessed 20 Mar 2017

http://eur-European Commission (2013b) Annual report on http://eur-European SMEs 2012/2013 http://knjiznica sabor.hr/pdf/E_publikacije/Annual_report_smes_2013.pdf Accessed 25 Mar 2017

European Commission (2014) Annual report on European SMEs 2013/2014 http://cepymeemprende es/sites/default/files/SME2013-2014.pdf Accessed 20 Mar 2017

European Commission (2015a) Annual report on European SMEs 2014/2015 http://www pmievolution.it/wp-content/uploads/2016/04/annual-report-SME-2015.pdf Accessed 15 Mar 2017

European Commission (2015b) Survey on the access to finance of enterprises (SAFE) analytical report

European Commission and Directorate-General for Enterprise and Industry (2010) ization of European SMEs https://wbc-rti.info/object/document/7933 Accessed 10 Jan 2017

International-EU Joint transfer pricing forum, European Commission (2011) Report on small and medium enterprises and transfer pricing DOC: JTPF/001/FINAL/2011/EN http://ec.europa.eu/taxa tion_customs/sites/taxation/files/resources/documents/taxation/company_tax/transfer_pricing/ forum/jtpf/2011/jtpf_001_final_2011_en.pdf Accessed 20 Feb 2016

OECD (2014) Model tax convention income-and-on-capital-2015-full-version-9789264239081-en.htm Accessed 10 Apr 2017 OECD (2015) Taxation of SMEs in OECD and G20 countries http://www.oecd.org/publications/ taxation-of-smes-in-oecd-and-g20-countries-9789264243507-en.htm Accessed 30 Mar 2017 OECD (2017) Transfer pricing guidelines for multinational enterprises and tax administrations http://www.oecd.org/tax/transfer-pricing/oecd-transfer-pricing-guidelines-for-multinational- enterprises-and-tax-administrations-20769717.htm Accessed 11 Jul 2017

http://www.oecd.org/ctp/treaties/model-tax-convention-on-Transfer Pricing Rules for SMEs in the EU

The aim of this chapter is to provide the background of transfer pricing rules fromboth the theoretical and practical points of view The arm’s length principle isconsidered a key pillar of the rules; therefore, great emphasis is placed onexplaining these rules as well as their history and practical application TheOECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Admin-istrations (hereafter TP Guidelines) provide guidance for applying the arm’s lengthprinciple to pricing for tax purposes and to cross-border transactions betweenassociated enterprises; therefore, the chapter provides a detailed explanation ofthe TP Guidelines, particularly a comparability analysis, which is considered thecore issue in the application of the arm’s length principle, transfer pricing methods,and documentation requirements and administrative approaches to transfer prices.However, TP Guidelines make no direct distinction between types or sizes ofmultinational enterprises; i.e., all enterprises, regardless of their size, are subject

to the same principles and recommendations Therefore, the chapter also focuses ontransfer pricing rules in relation to SMEs, critical concerns in transfer pricing andcompliance costs issues The last part focuses on recommendations, namely, anintroduction of safe harbour and common (consolidated) corporate tax base

and Role in the Twenty-First Century

The arm’s length principle, which was established as a rule against manipulatingtransfer prices (and ultimately, therefore, manipulating the volume of the tax base),represents the key pillar of the transfer pricing rules and a standard that has beenused in the international tax field since 1933 Under this principle, associatedenterprises must set transfer prices for any intra-group transaction in the sameamount as they would be set between the unrelated entities, and all other aspects

© Springer International Publishing AG 2018

V Solilova, D Nerudova, Transfer Pricing in SMEs, Contributions to Management

Science, https://doi.org/10.1007/978-3-319-69065-0_2

9

of the relationship are unchanged The international consensus is that the taxableprofits realized by an enterprise from controlled transactions should not be distorted

by the relationship that exists between the parties but should be comparable to theprofits that the enterprise would have realized if it had been dealing in comparableconditions with an independent party It also means that the conditions of controlledtransactions do not differ from the conditions that would be obtained in comparableuncontrolled transactions and thereby transfer prices reflect market forces Oncetransfer prices do not reflect market forces and, therefore the, arm’s length princi-ple, the tax liabilities of the associated enterprises and the tax revenues of thesecond tax jurisdiction could be distorted Any such distortions shall be corrected

by a primary adjustment and thereby ensure that the arm’s length principle is met.From the practical point of view, it can be conducted by the imputing or reducing ofprofits/expenses of associated enterprises and establishing the conditions of thecommercial and financial relations that they would expect to find between inde-pendent enterprises in similar transactions under similar circumstances

The authoritative statement of the arm’s length principle can be found in Article9(1) of the OECD Model Convention on Income and Capital (hereinafter as OECDModel Convention1) known as primary adjustment:

When conditions are made or imposed between two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

As state Wittendorf (2010) and OECD (1977,1992,2010a,2014), the primarypurpose of Article 9 of the OECD Model Convention is to prevent economic doubletaxation2caused by a transfer pricing adjustments Article 9 comprises two parts:

• Article 9(1) considers the primary adjustments mentioned above, whose legalbasis and the method of its application shall be stated in national tax law andwhose application is not conditional on the other contracting state agreeing withthe adjustment

• Article 9(2) addresses corresponding adjustments

The provision about corresponding adjustment in cases of associated enterpriseswas added to Article 9 during the first revision of the OECD Model Convention in

1977, with the purpose of avoiding economic double taxation in cases, where onetax administration adjusts associated enterprise’s taxable profits due to a primaryadjustment—i.e., applying the arm’s length principle to controlled transactionsinvolving an associated enterprise in a second tax jurisdiction As mentioned inthe TP Guidelines (para 4.32), the corresponding adjustment is a downward

1 OECD: Model Tax Convention on Income and Capital.

2 The treaty protection under Article 9(1) is applied to both actual and virtual double taxation In contrast, a corresponding adjustment under Article 9(2) is only available with respect to actual double taxation For further details, see Solilova and Steindl ( 2013 ).

adjustment to the tax liability of that associated enterprises (made by the taxauthority of the second jurisdiction), so the allocation of profits between thejurisdictions is consistent with the primary adjustment, and no double taxationoccurs.3 However, with respect to OECD (2010a, b, 2014 and 2017),4 acorresponding adjustment is not made automatically, but once the contractingstate agrees that the primary adjustment is justified both in principle and in theamount, then a corresponding adjustment shall be made; i.e., the other contractingstate is not liable to make a corresponding adjustment if it considers the transaction

to have been conducted at arm’s length, resulting in the situation of economicdouble taxation.5

In cases of transfer pricing dispute resulting in economic double taxation, Article9(2) suggests considering corresponding adjustment requests under mutual agree-ment procedure of Article 25 OECD Model Convention Moreover, as the OECD(2010b,2017) states, it is also recommended in cases when double tax treaties do notinclude the corresponding adjustment statement in Article 9(2) This situationoccurred frequently at the beginning of the period when the corresponding adjust-ment was introduced by the OECD in Article 9(2) due to uncertainty about itsmandatory or non-mandatory application.6Therefore, some of the OECD memberstates raised the reservation to Article 9(2) OECD Model Convention in the follow-ing forms: (i) to obtain the right not to insert paragraph 2 in the double tax treaties but

to be prepared to accept this paragraph with an addition of a third paragraph whichlimits the potential corresponding adjustment to bona fide cases; (ii) or to makeadjustments in accordance with the procedure provided for by the mutual agreementonly; (iii) or only if they consider that the primary adjustment is justified.7

The introduction of the arm’s length principle and its implementation intodomestic tax framework is a matter not only for the OECD member countries butalso for the United Nations member countries The arm’s length principle is alsoexpressed in Article 9 of the United Model Double Taxation Convention betweenDeveloped and Developing Countries (hereinafter as UN Model Convention8) in anidentical form as in the OECD Model Convention However, the article includes

3 For more details see paras 4.32–4.39 of the TP Guidelines (OECD 2017 ) and para 11 of the Commentary on Article 9 of the OECD Model Convention.

4 For more details see OECD Commentary on Article 9(2), para 6, 2010a and TP Guidelines, para 4.35, 2017.

5 For more details see Wittendorf ( 2010 ), part 2 and 3.

6 Currently, the corresponding adjustment is not mandatory.

7 Currently, on the basis of the last revision in 2014, only four member states, namely, the Czech Republic, Hungary, Italy and Slovenia, have a reservation with respect to Article 9(2) OECD Model Convention Furthermore, Australia has a general reservation on Article 9 OECD Model Convention Moreover, there is one observation on Article 9 OECD Model Convention with regard to the thin capitalization made by the United States.

8 United Nations, “Model Double Taxation Convention between Developed and Developing Countries”, updated 2011 Available from: http://www.un.org/esa/ffd/documents/UN_Model_ 2011_Update.pdf

fraud exclusion in paragraph 3, which is not included in Article 9 of OECD ModelConvention:

The provision of paragraph 2 shall not apply where judicial, administrative or other legal proceedings have resulted in a final ruling that by actions giving rise to an adjustment of profits under paragraph 1, one of the enterprises concerned is liable to penalty with respect

to fraud, gross negligence or willful default.

The purpose of the third paragraph is to cover the situation when a contracting statedoes not need to make a corresponding adjustment via Article 9(2)

As is obvious from the statement of Article 9 in the OECD Model Conventionand UN Model Convention, administrative guidance is needed on the application oflegal basis relating to the arm’s length principle or methods how the primaryadjustment or corresponding adjustment shall be made However, no administrativeguidance9 was available until 1979, when the OECD published its first transferpricing report—The OECD Report on Transfer Pricing and Multinational Enter-prises (hereafter OECD Report), which was supplemented and followed by otherreports on the complexity of transfer pricing issues During the period 1992–1997,the OECD Report was significantly revised to reflect the developments in interna-tional trade A first important result of revision was a reference to this report beingincluded in the Commentary on Article 9 of the OECD Model Convention (1992),10which resulted in both the OECD Report, as a predecessor to the TP Guidelines, andthe TP Guidelines themselves are considered a way of interpreting Article 9 of theOECD Model Convention The second important result of revision is the TPGuidelines11being published and thus providing more detailed guidelines on theapplication of the arm’s length principle, as neither Article 9 nor the Commentaries

on Article 9 contain detailed guidance on the principle However, similar to theOECD Commentary, the TP Guidelines are not legally binding under internationaltax law, but they are considered a means of interpretation as far as they wereavailable when the respective tax treaty was signed, as stated (UN, Vienna Con-vention, Article 31, 1969).12 The aim of the TP Guidelines is to create an

9 Only in the US; the US Treasury issued regulations for specific types of intercompany actions in 1968, which was the motivation for the OECD to publish a guidance of transfer pricing issue.

trans-10 For more details see OECD Commentary 1992, Article 9 para 3.

11 The groundwork for the 1995 and other revisions of the TP Guidelines was laid by the OECD Report 1979 and OECD Mutual Agreement Report from 1984 In 2009, a limited update of TP Guidelines was made to reflect the adoption of update of the Model Tax Convention in the 2008 In the 2010 edition, significant revisions were made; namely, Chapters I–III and a new Chapter IX, on the transfer pricing aspects of business restructurings, was added Since 2013, the TP Guidelines has been a subject of a huge revision due to the results of individual actions of Base Erosion Profit Shifting project (hereinafter BEPS) Currently, the 2017 edition of the TP Guidelines reflecting a consolidation of the changes resulting from the BEPS project and other changes was released on

10 July 2017.

12 In this fact is relating the static and dynamic approach of interpretation of Tax Conventions For more details see https://www.wu.ac.at/fileadmin/wu/d/i/taxlaw/institute/staff/publications/ langbrugger_australiantaxforum_95ff.pdf , or see Wittendorf ( 2010 ), Chap 3.

international consensus on a common interpretation of the arm’s length principleand its application, according to the OECD (1997,2010b) Thus, as Owens (2005)states, the separate entity approach is considered the underlying concept supportingthe arm’s length principle Further, as the OECD (1997) notes in the TP Guidelines,the fundamental basis to the arm’s length principle is the equal treatment ofassociated and independent enterprises However, currently, this equal treatment

is often criticized by opponents of the arm’s length principle.13Moreover, becausethe TP Guidelines set treatments of transfer pricing issues with respect to multina-tional enterprises and regardless of the size or type of enterprise, the application ofthe arm’s length principle can be a resource-intensive process that results in heavycompliance costs, particularly for SMEs

The UN along the lines of the OECD published a practical Manual on TP forDeveloping Countries (known as the UN TP Manual) in 2013 Currently, the secondedition (2017) is available, which reflects the experience and developments in thearea of transfer pricing analysis and administration since 2013 and endorses thearm’s length standard for the pricing of transactions within associated enterprises.There are several reasons why OECD and UN member countries and othercountries have adopted the arm’s length principle The TP Guidelines highlightthat the main reason for adopting this principle is that it provides a broad parity oftax treatments for associated and independent enterprises, resulting in the avoid-ance of tax advantages or disadvantages among entities Therefore, as Cottani(2016) states, almost all countries introduced domestic tax provisions endorsingthis standard allowing adjusting transfer prices that deviate from the arm’s lengthprinciple In this context, as Solilova and Steindl (2013) mention, the primarypurpose of this standard is to ensure the compliance of domestic rules with thearm’s length principle with respect to transactions on business income betweenassociated enterprises with the objective of mitigating economic double taxation.However, they are many experts who view on this standard as inherently flawed,which is incompatible with today’s global economy, i.e., the global nature of interna-tional business, as Avi-Yonah and Clausing (2007) state; Durst (2010,2011) highlightsthat this standard is based on a fundamental misunderstanding of both practicaleconomics and the way in which multinational business is conducted The authorfurther notes that the current corporate tax system is based on faulty assumptionsand, therefore, on the unenforceability of the arm’s length principle resulting from itscentral premises: the comparison of profit from transactions among associated enter-prises with the results of comparable transactions among unrelated parties According

to the author, the activities of unrelated parties are systematically different from those

of associated enterprises; therefore, they cannot be comparable Moreover, it is lutely incorrect to evaluate the results of associated enterprises based on the assumptionthat they are a group of unrelated enterprises transacting with one another at arm’slength while holding associated enterprises to the arm’s length principle for pricingintra-group transactions, as state Avi-Yonah and Clausing (2007) and Durst (2010,

abso-13 For more details see last part of this Section.

2011) The authors add that this approach does not make sense anymore Such anapproach might well have made sense 80 years ago, when the arm’s length standard fortax purposes was first developed.

In 1930s, the arm’s length principle was considered a suitable allocation norm(Carrol1933)14because cross-border transactions were limited and business struc-tures were not as complex and complicated The principle was incorporated intointernational taxation law through the League of Nations Draft Convention on theAllocation of Profits and Property of International Enterprises in 1933 and by thefirst OECD Model Convention draft Tax Treaty (1963) with the same wording asthe London Model (1946) It is obvious that at that time, the nature of business andtechnology did not permit the close centralized management of associated enter-prises operating in different countries Therefore, comparing their activities/trans-actions with those of uncontrolled comparable entities probably made sense.However, with the technological changes, globalization and digital nature ofbusiness, it is economically infeasible to do business without controlled structure,resulting in markets with a lack of comparables, i.e., where it is unlikely to finduncontrolled comparable entities, as state Avi-Yonah and Benshalom (2010).Furthermore, there is some evidence that the arm’s length standard does notreflect either economic reality or whether the third party would enter the transac-tion, but instead, it proves the income shifting between enterprises, as stateKeuschnigg and Devereux (2013), Taylor et al (2015), Bartelsman and Beetsma(2000), Wells and Lowell (2014), Hines and Rice (1994), and Huizinga and Laeven(2006) It fully corresponds with the fact that the transfer pricing represents aninstrument that is used as tax planning tool; i.e., properly chosen transfer pricingstrategies can enable the distribution of the tax risks and profits, resulting in areduction of the overall corporate tax liability, as state Buus (2009), Solilova´ andNerudova´ (2012,2013), Swenson (2001), Rojı´cˇek (2012) and others Moreover, thecorporate income is taxed at the national level, whereas economic environment andbusiness models have become more complex and complicated with the increasinglyglobalized, mobile and digital nature of business Therefore, profit shifting is donemore easily, and the divergence of national corporate tax systems has created aspace for aggressive tax planning.15The international tax rules, including the arm’slength standard and tax systems, seem to be inefficient and non-transparent and arenot able to react on increasingly sophisticated tax planning structures

In this respect, the OECD (2013a) estimates annual losses from 4 to 10% ofglobal corporate income tax revenues, i.e., USD100–240 billion annually.16In the

14 One year previously, the first tax treaty was signed with an allocation norm for business income between associated enterprises in the form of the arm ’s length principle.

15 Aggressive tax planning involves taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems to reduce tax liability For more details, see Commission Recommendation of 6 December 2012 on aggressive tax planning, C(2012) 8806 final.

16 For more details see: 9789264192744-en.htm and https://www.oecd.org/ctp/beps-explanatory-statement-2015.pdf

http://www.oecd.org/tax/addressing-base-erosion-and-profit-shifting-EU, the estimation of annual losses of tax revenue is approximately EUR 1 trillion,and in the case of corporate taxation, approximately EUR 50–70 billion is lost.17Toavoid this practice and ensure the correct application of the separate entityapproach, in February 2013, the OECD and G20 countries18 launched a project

on Base Erosion and Profit Shifting (hereafter BEPS) that included 15 Actionplans19 referring to tax planning strategies and shifting profits to low or no-taxjurisdictions, resulting in little or no overall corporate tax being paid The finalreports of the project were published on 5 October 2015 Consequently, the TPGuidelines were updated and released on 10 July 2017, reflecting the recommen-dations from the BEPS project.20

To avoid the divergent implementation of BEPS by each EU Member States and

a disruption of the functioning of the internal market, the European Commissionpublished the draft of the Directive “laying down rules against tax avoidancepractices that directly affect the functioning of the internal market”, known as theAnti Avoidance Directive, on 28 January 2016, which was adopted after 5 months

by Council as a Directive 2016/1164.21 Furthermore, on 28 January 2016, theCommission proposed a framework for a new EU external strategy for effective

17 For more details see: European Parliamentary Research Service Aggressive corporate tax planning under scrutiny http://www.europarl.europa.eu/RegData/etudes/ATAG/2015/571345/ EPRS_ATA(2015)571345_EN.pdf

18 The EU confirmed support for work within the BEPS project in May 2013, see Council document 9405/13

19 For the transfer pricing issue, only two deliverables of BEPS project focus on it: Action plan 8–10 “Aligning Transfer Pricing Outcomes with Value Creation” and Action plan 13 “Guidance

on Transfer Pricing Documentation and Country-by-Country Reporting” Based on the Action Plan 13, all enterprises are required to report information relating to their economic activity such

as revenues, profits, taxes paid and certain measures of economic activity, and to articulate their consistent transfer pricing positions through this standardized approach of reporting Thus, a new reporting obligation is required for the current transfer pricing documentation Based on the Action plan 8–10, in the area of transfer pricing analysis and determination of transfer prices, a correct application of the arm ’s length standard demands an understanding of the value drivers and relevant risks involved and how responsibility for those risks is attributed among the associated enterprises in the context of their commitment to creating value jointly For the level and assumption of risk are economically relevant characteristics that can be significant in determining the outcome of a transfer pricing analysis.

20 Only one part is waiting on the revision, particularly the section related to the profit split method, due to on-going work.

21 Anti-Tax Avoidance Directive contains five legally-binding anti-abuse measures (Controlled foreign company (CFC) rule, switchover rule, exit taxation, interest limitation, and general anti- abuse rule) which all Member States should apply against common forms of aggressive tax planning It creates a minimum protection for all Member States ’ corporate tax systems by transposition of the OECD BEPS measures into their national systems in a coherent and coordi- nated fashion and ensures a fairer and more stable environment for business Member States should apply these measures as from 1 January 2019.

taxation22 with the aim of promoting good tax governance globally, tacklingexternal base erosion threats and ensuring a level playing field for all businesses.However, it is not clear whether steps performed through BEPS will lead to theproper application of the arm’s length standard and proper corporate incometaxation and whether those steps are just another patch on the already inadequateand inefficient corporate income tax system, which can generate annual lossesbetween EUR 50 and 190 billion23due to profit shifting and system inefficiencies.Therefore, the issue of possible alternatives to the arm’s length principle (as anallocation norm) should be discussed because, as discussed above, the arm’s lengthprinciple can no longer be considered the fairest and most reliable basis fordetermining where taxable profits fall.

The following part of the chapter is aimed at discussing the comparabilityanalysis as the key part of the application of the arm’s length principle, practicalapplication of transfer pricing methods, documentation of transfer prices andtransfer pricing rules in the context of SMEs, in light of 2017 update of the TPGuidelines covering the recommendations that resulted from the BEPS project

As mentioned above, the central premise of the arm’s length standard is thecomparison of conditions of controlled transactions with those of comparableuncontrolled transactions The comparability analysis plays a crucial role becausebased on its results, the most appropriate transfer pricing method is selected, and thearm’s length price or margin is determined There is no doubt that it represents acore part of the application of the arm’s length standard

Selecting the appropriate transfer pricing method depends on the consideration

of the all connected circumstances of the case For this purpose, the selectionprocess should consider the strengths and weaknesses of each method recognized

by the TP Guidelines The suitability of the method should be considered in theview of the nature of the controlled transaction and should be determined through afunctional analysis, which is an important part of the comparability analysis.Therefore, the TP Guidelines have set five comparability factors that may beimportant in a comparability determination:“The characteristics of the propertyand services transferred, the functions performed by the parties with taking intoaccount assets used and risks assumed (known as functional analysis), the

22 See COM(2016)24final, available at http://eur-lex.europa.eu/legal-content/EN/TXT/? uri ¼CELEX%3A52016DC0024

23 For more details see: European Parliamentary Research Service Aggressive corporate tax planning under scrutiny http://www.europarl.europa.eu/RegData/etudes/ATAG/2015/571345/ EPRS_ATA(2015)571345_EN.pdf

contractual terms, the economic circumstances of the parties, and the businessstrategies pursued by the parties.” The selection process should also consider theavailability of reliable information needed to apply the selected method(s) and thedegree of their comparability.24 In addition, for a functional analysis, the TPGuidelines state (para 1.51, OECD2017), that the following may be helpful:

• to understand the structure and organization of the group and how they influencethe context in which the taxpayer operates,

• how value is generated by the group as a whole, the interdependencies of thefunctions performed by the associated enterprises with the rest of the group andits contribution to that value creation,

• and to determine the legal rights and obligations of the taxpayer in performing itsfunctions with respect of the basic principle that the functions carried out willusually determine the allocation of risks between parties

It means that functional analysis seeks toidentify the commercial and financialrelations between the associated enterprises, the conditions and economicallyrelevant circumstances attaching to these relations in order that the controlledtransaction is accurately delineated.25

To accurately delineate the actual transaction with respect to the functionsperformed, assets used and risks assumed, the TP Guidelines state(Section D.1.2., Chapter 1, OECD2017) that a functional analysis compares theeconomically significant activities and responsibilities undertaken, assets used andrisks assumed by the parties to the transactions The functions that taxpayers and taxadministrations might need to identify and compare, include the capabilities of theparties, type of assets used (e.g., plant and equipment, the use of valuable intangi-bles, financial assets), logistics, warehousing, marketing, sales, design of products,manufacturing, assembling, research and development, servicing, purchasing, dis-tribution, advertising, transportation, financing, and management The economi-cally significant risks26assumed by each party can be categorized in various ways,but a relevant framework in a transfer pricing analysis is to consider the sources ofuncertainty that give rise to risk Based on these sources of uncertainty, the TPGuidelines (para 1.72, OECD2017) now classify risks (as a non-exclusive list ofrisks) as strategic or marketplace risks, infrastructure or operational risks, financialrisks, transactional risks and hazard risks Further, human and intellectual capitalrisks can be identified during the functional analysis Reference is also made to risksthat are externally driven and those that are internally driven to help clarify thesources of uncertainty

24 The term “degree of comparability” is defined as the comparability between controlled and uncontrolled transactions.

25 For more details see para 1.33, and section D.1.2., Chapter 1 TP Guidelines, OECD 2017

26 The significance of a risk depends on the likelihood and size of the potential profits or losses arising from the risk.

Identifying risks, functions and assets is an integral part of both identifying thecommercial and financial relations between associated enterprises and accuratelydelineating the transactions In this respect, it is important to note that the definition

of risks in business should neither be performed on the primitive level (i.e., justlisting the risks from the general point of view) nor interpreted as risks being moreimportant than functions or assets The practice, however, showed that it can bemore difficult to identify the risks in a transaction than functions and assets The TPGuidelines therefore introduce asix-step process to analyse the risks (in para 1.60,OECD2017), which can be summarized as follows:

1 Identification of economically significant risks in the relevant relationalcontext27

2 Determination of how risks are contractually assumed under the terms of thetransaction

3 Determination through a functional analysis which enterprise(s)

– perform(s) control functions and risk mitigation functions,

– encounter(s) upside or downside consequences of risk outcomes, and– have(s) the financial capacity28to assume the risks

4 Determination of whether the contractual assumption of risks is consistent withthe conduct of the associated enterprises by analysing whether

– the associated enterprises follow the contractual terms; and

– the party assuming risk exercises control29over the risk and has the financialcapacity to assume the risk

5 Where the party assuming risk does not control the risk or have the financialcapacity to assume the risk, then the risk should be allocated to the entityexercising control and having the financial capacity to assume the risk

27 The identification of an associated enterprise(s) assuming risks is usually set out in written contracts between the parties to a transaction involving these risks A contractual assumption of risk constitutes an ex ante agreement to bear some or all of the potential costs associated with the

ex post materialization of downside outcomes of risk in return for some or all of the potential benefit associated with the ex post materialization of positive outcomes It must be highlighted that

an ex ante contractual assumption of risk should provide clear evidence of a commitment to assume risk prior to the materialization of risk outcomes Such evidence is a very important part of the tax administration ’s transfer pricing analysis of risks in commercial or financial relations.

28 Financial capacity in this area means the access to funding to take on the risk or to lay off the risk, to pay for the risk mitigation functions and to bear the consequences of the risk if the risk materializes If the financial capacity to assume a risk is lacking, then the allocation of risk requires consideration under step 5 above.

29 Control over risk, as the last essential part of analyzing risks, involves the capability to make decisions to take on, lay off, or decline a risk-bearing opportunity, and the capability to make decisions on whether and how to respond to the risks associated with the opportunity Day-to-day mitigation is not necessary to be performed in order to have control of the risks; i.e., these activities can be outsourced.

– In case of multiple associated enterprises that both exercise control and havethe financial capacity, then the risk should be allocated to the entity(ies) thathave the most control.

6 The actual transaction as accurately delineated by considering the evidence ofthe economically relevant characteristics of the transaction and should be price,taking into account the financial and other consequences of risk assumption.30

It is obvious that a more comprehensive and realistic approach to the risk isinevitable, as well as an understanding of the drivers of the value in the enterprise.Further, how the associated enterprises can be rewarded depends on theex ante and

ex post analyses of company price policy Moreover, the responsibilities of entitieswith respect to different risks affect the final remunerations for those entities; i.e.,

ex post outcomes can only be understood and explained in view of thoseresponsibilities

To summarize, an accurately delineated transaction should also be priced inaccordance with the financial and other consequences of risk assumption and theremuneration for risk management Thus, a taxpayer that both assumes and miti-gates a risk should be entitled to greater anticipated remuneration than should ataxpayer that only assumes or mitigates a risk but does not do both With respect tothe recognition of the accurately delineated transaction, the key question in theanalysis is whether the actual transaction possesses the commercial rationality ofarrangements that would be agreed between unrelated parties under comparableeconomic circumstances rather than whether the same transaction can be observedbetween independent parties

For the other parts of the comparability analysis, a nine-step process forperforming a comparability analysis was added to the TP Guidelines in 2010,representing an accepted good practice:

• Step 1: Determination of years to be covered

• Step 2: Broad-based analysis of the taxpayer’s circumstances

• Step 3: Understanding the controlled transaction(s) under examination, based inparticular on a functional analysis

• Step 4: Review of existing internal comparables, if any

• Step 5: Determination of available sources of information on external comparables

• Step 6: Selection of the most appropriate transfer pricing method

• Step 7: Identification of potential comparables

30 The TP Guidelines now use the term “risk management”, which refers to the function of assessing and responding to risk associated with commercial activity Risk management means taking on both the upside and downside consequences of the risk with the result that the party assuming a risk will also bear the financial and other consequences if the risk materializes Risk management is addressing the impact of volatility on profits and value; therefore, associated enterprises must identify the source and impact of volatility on their business to manage risks better.

• Step 8: Determination of and making comparability adjustments whereappropriate.

• Step 9: Interpretation and use of data collected, determination of the arm’slength remuneration

The “broad-based analysis” is an essential step in the comparability analysissince it helps in understanding the conditions in the taxpayer’s controlled transac-tion and those in the uncontrolled transactions to be compared, particularly theeconomic circumstances of the transaction As a common source of information forthe comparability analysis serves commercial databases, which can be a practicaland occasionally cost-effective way of identifying external comparables and mayprovide the most reliable source of information, depending on the facts andcircumstances of the case However, the use of commercial databases should notencourage quantity over quality

The process of identifying potential comparables is one of the most importantaspects of the comparability analysis with the objective of finding the most reliabledata The TP Guidelines, in para 1.33 (OECD 2017) describe this process “ascomparing the conditions and the economically relevant circumstances of thecontrolled transaction as accurately delineated with the conditions and the eco-nomically relevant circumstances of comparable transactions between independententerprises” However, the TP Guidelines bear in mind the burden of an exhaustivesearch of all possible sources of comparables or the considering of all methods aswell as limitations in information availability, namely, in case of SMEs Therefore,the aim is to find the most reliable data under the circumstances of the case,recognizing that they will not always be perfect.31 To combat this issue isrecommended to use some statistical methods In this respect, Cottani (2016)adds that taxpayers are at risk if the comparables search process is not sufficientlythorough The EU JTPF is aware of the risks and difficulties involved in thecomparability analysis and thus, in 2016, released the Report on the Use ofComparables in the EU containing recommendations and good practice in respect

of search strategy and specific aspects of comparability adjustments in line with thearm’s length principle.32The current practices observed by both taxpayers and taxadministration are explained and presented in Fig.2.1 As is obvious, the first step issetting the analysis with the aim of ensuring the objectivity of the process Thesecond step is the quantitative analysis covering the process of Boolean search ofexternal potential comparables through industry sectors codes, keywords, turnoverthresholds, independence tests,33 “diagnostic ratios”34 and others, for which

31 For more details see TP Guidelines para 3.2, 3.80–3.83, and 3.57 OECD 2017

32 For more details, EU JTPF report available at: https://ec.europa.eu/taxation_customs/sites/taxa tion/files/jtpf0072017encomps.pdf

33 It is worth noting that percent-based indicators reflecting a maximum share of interest owned in subsidiaries differ significantly among the EU member states, particularly between 20% and 50%.

34 Diagnostic ratios represent certain ratios of balance sheet / profit and losses account items of the tested party, which are compared with those of potential comparables and can help increase

multiple year data covering a time period of 3–5 years are recommended The laststep is a qualitative analysis that covers the manual analysis of potential compara-bles received through the previous step, namely, website, company reports, finan-cial statements, detailed independence test, and losses.

Further, it is important to note that two transactions are seldom completelycomparable in currently existent “imperfect” environment As highlights Cottani(2016) an apple-to-apple comparison is not possible as In accordance with TPGuidelines (para 3.47, OECD 2017), “to be comparable means that none of thedifferences (if any) between the situations being compared could materially affectthe condition being examined in the methodology, or that reasonably accurateadjustments can be made to eliminate the effect of any such difference” Therefore,

if there are material differences on prices or profits between controlled anduncontrolled transactions, the reliability of comparability adjustments that mayeliminate these differences between them should be considered with aim to improvethe reliability of the comparability analysis’s results Furthermore, it has to bementioned that even in cases where comparable data are scarce and imperfect,

1 Setting of the analysis scope

Determination of the approach underlying the analysis

Selection of the tested party

Determination of the comparability factors

Selection of the data base

Timing of origin of data

Multiple year data coverage

Selection of the initial sample from the database

- Selection of industry sector (code of activities) / keywords

- Geographical scope Application of the screening criteria

Fig 2.1 Selecting of external comparables—current practice (EU JTPF 2016 , adjusted)

valuable input of the comparability analysis, namely, whether the potential comparables match these ratios of the tested party.

the selection of the most appropriate transfer pricing method should be consistentwith the functional analysis of the parties.

However, in para 1.11 (TP Guidelines, OECD2017), it is mentioned that nothaving comparables does not itself mean that the transactions between associatedenterprises are not at arm’s length This statement can be considered crucialbecause there are some significant cases in which the arm’s length principle isdifficult and complicated to apply An example may be the case of integratedproduction of highly specialized goods, in unique intangibles, and/or in the provi-sion of specialized services A practical difficulty in applying the arm’s lengthprinciple is that associated enterprises may be engaged in transactions that inde-pendent enterprises would not undertake Such transactions may not necessarily bemotivated by tax avoidance In some cases, it will be possible to apply the arm’slength principle to arrive at a single figure (e.g., price or margin) that is the mostreliable to establish whether the conditions of a transaction are at arm’s length.However, because transfer pricing is not an exact science, there will also be manyoccasions when the application of the most appropriate method or methods pro-duces a range of figures that are all relatively equally reliable In these cases,differences in the figures that comprise the range may be caused by the fact that

in general, the application of the arm’s length principle only produces an imation of the conditions that would have been established between dependententerprises It is also possible that the different points in a range represent the factthat independent enterprises engaged in comparable transactions under comparablecircumstances may not establish exactly the same price for the transaction Toenhance the reliability of comparable analysis, the TP Guidelines (para 3.57, OECD

approx-2017) and EU JTPF (2016) recommend narrowing the range by using statisticalmethods (i.e., the interquartile range, other percentile)

In general, the search for information on potentially comparable uncontrolledtransactions and the process of identifying potential comparables is dependent onprior analyses of the taxpayer’s controlled transaction and the relevant compara-bility factors The entire analytical process should be consistent, transparent,systematic and verifiable, from the preliminary analysis of the conditions of thecontrolled transaction, to the identification of potential comparables, to the selec-tion of the transfer pricing method, and ultimately to the conclusion about whetherthe controlled transactions are consistent with the arm’s length standard There is nospecific procedure for SMEs; therefore, they have to follow the same principles,rules and recommendations through the TP Guidelines In addition, it is a goodpractice for taxpayers to set up a process to establish, monitor and review theirtransfer pricing policy, and they should expect to provide documentation demon-strating the conduct of a detailed comparability analysis

2.3 Transfer Pricing Methods and Their Practical

Application in the Twenty-First Century

To establish whether the conditions imposed in the commercial or financial tions between the associated enterprises are consistent with the arm’s lengthprinciple, the TP Guidelines distinguish among five transfer pricing methods,which are known as traditional transaction methods (these methods are comparableuncontrolled price method or CUP method, the resale price method or RPM, andcost plus method or COST+) and transactional profit methods (these methods aretransactional profit split method and the transactional net margin method orTNMM) Further, associated enterprises are free to apply methods not described

rela-in the TP Guidelrela-ines, provided that the arm’s length principle is followed (para 2.9

TP Guidelines, OECD2017)

The first method,the comparable uncontrolled price method (hereafter CUP),compares the price charged for property or services in a controlled transaction to theprice charged in a comparable uncontrolled transaction between independent enter-prises in comparable circumstances If there is any difference between the prices, itmay indicate that the arm’s length principle is not followed and that the primaryadjustment (through Article 9(1) of OECD Model Convention) should be consid-ered and subsequently performed based on the result of the consideration The CUPmethod is the most direct and reliable way to apply the arm’s length principlebecause any difference in the prices (between controlled and comparableuncontrolled transactions) can be traced directly to the commercial and financialrelations made or imposed between the enterprises because and the arm’s lengthconditions can be established by directly substituting the price in the comparableuncontrolled transaction for the price of the controlled transaction Thus, for thecase of CUP, the price of controlled transaction is equal to the price of comparableuncontrolled transaction, provided that the commercial and financial relations arecomparable

The major breakthrough of the 2010 update of the TP Guidelines represents theintroduction of a new concept in the form of the “most appropriate method”, whichresulted in the removal of the distinction between traditional and profit methods.Currently, the selection of the most appropriate method is based on the circum-stances of the case However, as the TP Guidelines state (para 2.3, OECD2017),where the CUP method and another transfer pricing method can be applied in anequally reliable manner, the CUP method is to be preferred

Under the second method, theresale price method, the reseller’s gross margin on

a product that is purchased from an associated enterprise and resold to an dent enterprise, is compared to the gross margin on product purchased from anindependent enterprise in light of its comparable functions, assets and risks Anappropriate gross margin known as resale price margin represents the costs of goodssold and an appropriate profit in the light of the functions performed, assets usedand risks assumed After subtracting the gross margin from the sales price (i.e.,price at which a product is resold to an independent enterprise), an arm’s length

indepen-price remains for the original transfer of the property between associatedenterprises.

The third method, the cost plus method, tests whether the profit mark-upscharged in a controlled transaction conducted at arm’s length compared with theprofit mark-ups charged in comparable uncontrolled transactions In applying theCOST+ method, the cost base should sufficiently and reasonably reflect the costsborne under the results of functional analysis reflecting appropriate allocation key.Appropriate profit mark-ups is then added to this cost base, resulting in an arm’slength price for the original controlled transaction

Transactional profit methods (TNMM and profit split) can be considered themost appropriate methods in cases where the parties make unique and valuablecontributions to the transaction, they engage in highly integrated activities or there

is no or limited publicly available data on independent third parties The fourthmethod, the transactional net margin method, operates in a similar way as theCOST+ and RPM methods However, the TNMM method examines the net profits,relative to an appropriate base, that an associated enterprise earned in controlledtransactions and compares them to the net profits realized from comparableuncontrolled transactions The method operates on the basis of profit-level indica-tors The choice of a profit-level indicator and the suitability of its applicationdepend on the results of functional analysis The selection of the denominatorshould be consistent with the comparability analysis of the controlled transaction,and in particular, it should reflect the allocation of risks between associatedenterprises

The last method, theprofit split method, is the only method that is based on acomprehensive two-sized approach with the aim of determining appropriate profitsfor all associated enterprises engaged in the controlled transaction by reference tothe conditions that would have been obtained between independent enterprises incomparable transactions and comparable circumstances There are a number ofapproaches for estimating the division of profits; however, the TP Guidelinesrecommend two approaches: contribution analysis and residual analysis.35Considering the recommended transfer pricing methods, it is obvious that theapplication of the arm’s length principle is based on a comparison of the price,margin or profits from particular controlled transactions with the price, margin orprofits from comparable transactions, contrary to the profit split method, which isbased on an approximation of the division of profits that independent enterpriseswould have expected to generate from engaging in the transaction.36It can be saidthat CUP compares prices, RPM compares gross margin, COST+ compares profitmark-ups on costs and TNMM analyses net profits in relations to an appropriate

35 Currently, the Chapter III, part III, section C—Transactional profit split method, in the TP Guidelines (OECD 2017 ) is without update due to the on-going work based on the BEPS project Therefore, the profit split method is not described in detail.

36 For more details see Chapter II TP Guidelines, 2017.

base, such as sales or operating revenue, costs (usually total operating costs) orassets.

It is worth highlighting that the selection of the most appropriate method doesnot mean the deep analysis and testing of all transfer pricing methods because the

TP Guidelines do not require using more than one method for analysis.37

The TP Guidelines state that the essential part of selecting the most appropriatemethod is to identify the strengths and weaknesses of the considered transferpricing methods Therefore, the following section is aimed to identify these char-acteristics for the mentioned methods

As is obvious from Tables2.1,2.2and2.3, each of the recommended transferpricing methods has at least one weakness The preferred CUP method, which isconsidered the most direct and reliable way to apply the arm’s length principle, ispresented with several weaknesses as well as, in practice, the most frequently usedTNMM method Therefore, it is desirable to select the appropriate transfer pricingmethod with respect to circumstances of the case, considering the strengths andweaknesses of the methods and the results of comparability and functional analyses,and the nature of the controlled transaction

Critique Aspects

The application of the CUP method is based on internal or external comparableuncontrolled transactions, when internal comparable uncontrolled transactions areconsidered for the most reliable arm’s length results Furthermore, the CUP methodallows the prices to be compared in either the direct or indirect form The directprice comparison is possible when none of the differences materially influence theprices, in contrast to indirect price comparison, when the effects of differences areeliminated through accurate adjustments In practice, due to very high comparabil-ity standards,38it is often difficult to identify comparable uncontrolled transactionswhere no adjustments should be performed Therefore, if the CUP method isapplied, the indirect price comparison prevails, and the relative reliability of theCUP method after adjustments must be considered Furthermore, as King (2010)

37 For more details see para 2.8., 2.12 TP Guidelines, OECD 2017

38 Transactions must be similar or the same in terms of product type, contractual terms, design, functionality and quality, geographic market, level of market, functions performed, assets used and risks assumed, etc.